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16 February 2015

The 4 Most Important Money Issues That Determine Your Financial Health

We often hear that Americans need to save more money or plan better for retirement, but what does it mean to be financially healthy? Personal finance can be a difficult subject to discuss since everybody’s financial situation is different — hence the word “personal.” However, new research shows that there is just a handful of elements needed to establish your financial well-being.The Consumer Financial Protection Bureau (CFPB) recently polled people across the country to hear what they had to say about financial well-being. While savings and income levels play a significant part, they are not always the most important elements. In short, financial well-being can be defined as a state of being wherein a person can fully meet current and ongoing financial obligations, can feel secure in their financial future, and is able to make choices that allow enjoyment of life.

Let’s take a look at the four most important elements of your financial health in detail.1. Feeling in control

People typically like control over their own lives. Those who have high levels on financial health feel in control of their daily and monthly finances. This means they have enough money to pay their bills on time, and generally do not have to worry about having enough money to get by. Interestingly, this is not necessarily about having a lot of money, but rather managing the money you already have in an efficient manner. This aspect of financial well-being was mentioned most frequently during the qualitative interviews conducted by the CFPB.

2. Capacity to absorb financial shocks

Life is full of expensive surprises. The ability to absorb the monetary shock of an unexpected mechanic bill or job layoff is a crucial element of your financial health. Americans possessing this trait typical have a safety net of savings, insurance, or at least family members to help stop a financial shock from turning into a longer-lasting setback. Unfortunately, many Americans do not have their own rainy-day fund.

According to a recent survey from Bankrate, only 38% of Americans have enough money in their savings accounts to pay for life’s little surprises, such as a $500 car repair or a $1,000 emergency room visit. If a financial emergency arises, 22% plan to cover the bill by reducing spending elsewhere, 16% say they will borrow money from family and friends, and 12% expect credit cards to fill the hole — potentially leading to even bigger problems down the road.

The ability to use savings for unexpected expenses improves with age, education, and income, but still leaves much to be desired. Only 44% of senior citizens have enough savings, compared with 33% of millennials. Meanwhile, 52% of college graduates have enough savings to cover financial emergencies, compared to 32% of those without a college degree. A convincing majority of 62% is only seen with households making at least $75,000 per year.

3. On track to meet goals

Tony Robbins once said, “Setting goals is the first step in turning the invisible into the visible.” In addition to helping us reach milestones, measurable and attainable goals aid in building high financial well-being. The CFPB finds that consumers who set goals and remain on track to accomplish them have a higher sense of financial health. Whether these goals were part of a formal financial plan was irrelevant. Simply having a goal to work toward boasts financial well-being. Think of this as moving toward financial freedom and rewarding your future self.

Failure to plan leads to a lack of savings. Research from HSBC reveals that people with a financial plan in place save the most money for retirement. Not including money put towards mortgage payments or home improvements, people with no financial planning save an average of $77 per month. Those with some kind of informal planning such as “my own thoughts” or “my own approximate calculation” save an average of $335 per month.

If you need help creating a financial plan, there is no shame in seeking professional assistance from a qualified adviser you trust. Savers in the HSBC study who had a financial plan in place with a professional adviser had accumulated $203,228 in retirement savings, compared to only $98,005 among those without a financial adviser.

4. Flexibility to make choices

No matter how well you plan, life has a funny way of surprising you. Consumers with high levels of well-being have the financial freedom to make choices that allow them to enjoy life, whatever that means to them. Whether that is taking a family vacation, going out to eat, or working less to spend more time with family, these consumers have the financial flexibility to do what they value and what makes them happy. The CFPB describes this as having financial freedom in the present.

While the best things in life are often free, having a large amount of debt can restrict your flexibility. After all, borrowing today represents a loan from your future production. More debt means more interest payments, which translates to more work and less freedom to do what you really want. Sadly, the average American will pay an estimated $279,002 over their lifetime in interest payments.

Applying the CFPB’s financial well-being framework to your own financial life will help you feel more satisfied with the decisions you make. When you face a financial choice or task, consider how your actions might affect financial security and financial freedom, today and in the future.